Brad Setser

Brad Setser: Follow the Money

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I hope Norway’s government fund didn’t short Iceland this time around

by Brad Setser
March 31, 2008

Iceland believes it has been "attacked" by a group of big hedge funds and broker dealers — presumably a different group of hedge funds than the funds that were playing the krona carry trade. Ibison of the FT:

Iceland’s Financial Supervisory Authority has begun an official investigation into alleged speculative attacks by international hedge funds on the country’s currency and stock market, according to people close to the probe.

Simultaneously, Kaupthing, one of Iceland’s leading banks, is considering legal action against Bear Stearns, the troubled US bank, for the role it played in a trip to Iceland by a group of hedge funds last January.

The double moves highlight Iceland’s exasperation with the alleged role professional international investors are playing in undermining its currency, the krona, and its stock market.

Iceland is both open and small — both relative to other economies and relative to many financial balance sheets — so moves by a few large financial firms can have an outsized impact on its market.   Hong Kong is a much bigger market.  But it isn’t all that big, and in the face of large speculative bets against both its currency and domestic equity markets back in 1998,  the HKMA ended up intervening heavily in its domestic stock market (see Krugman).

I have to think that if Norway’s government fund was aggressively shorting Iceland’s banks (as it supposedly did the last time Iceland faced trouble), that would be a huge political issue around now. Norway’s government fund has argued that its short position last time around was "just business" — a purely commercial bet. Iceland didn’t see it that way.

The possibility that CITIC might have been caught up in the Fed’s decision making around Bear suggests at least to me that the risk that sovereign funds will result in the "general politicization" of financial decision-making is real.

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